The Federal Inland Revenue Service (FIRS) issued a circular to clarify some of the changes to the Companies Income Tax Act (CITA) introduced by the Finance Act (FA) 2020. This circular is an update of an earlier circular issued in May 2020 on sundry changes to CITA introduced by the FA 2019 (“2019 circular”).
Key Highlights of the Circular
We have provided key highlights of the circular as follows:
- Interest Relating to Agricultural Loans
FA 2020 revised the conditions for the tax exemption on interest on loans granted by financial institutions for agricultural purposes. Qualifying business must be carrying out primary agricultural production and not just general agricultural trade or business. The minimum moratorium period in the loan agreement was also reduced from 18 to 12 months, and the interest rate on the loan cannot exceed the base lending rate.
Primary agricultural production was defined as primary crop production, primary livestock production, primary forestry, and primary fishing production.
- Small companies and CIT
Small companies with gross turnover not exceeding NGN 25 million are exempt from CIT. FIRS listed the conditions necessary for getting exemption from tax and stated that a small company that defaults in meeting the conditions shall be liable to penalties.
FIRS reserves the power to assess the small company to an administrative or best of judgment (BOJ) assessment where the company refuses to file CIT returns as and when due.
- Small companies and TET
The amendment to the TET Act now expressly clarifies that small companies are not liable to TET
- Donations for Pandemics and Natural Disasters
Donations made in cash or kind to any fund set up by the Federal, State or any agency designated by the government in respect of any pandemic or natural disaster shall be tax-deductible to a maximum of 10% of assessable profits after all other allowable donations (the circular erroneously uses ‘deductions’ here as against ‘donations’). Documentary evidence of such donations shall be provided in proof of tax deductibility.
In the circular, the FIRS used an illustration to demonstrate how to apply the three restrictions applicable in determining deductible donations; namely:
- donations to educational institutions -15% of total profit before deduction of donations
- donations to non-educational institutions –10% of total profit before deduction of donations
- donations made in cash or kind to fund set up by any agency of the government in respect of any pandemic or natural disaster –10% of assessable profits after deduction of other allowable donations
- Expenses Incurred in Earning Exempt Income
CITA disallows expenses incurred to generate exempt income. However, there is no clarity on the amount of expenditure to be disallowed where the expense is incurred to earn taxable and non-taxable income. In the 2019 circular, the FIRS recommended using a pro-rata approach to determine the expense to be disallowed in such cases.
In the 2020 circular, the FIRS proposes a more detailed method for determining expenses attributable to tax-exempt income, as follows:
- Cost directly and solely incurred to earn each class of income shall be separated, e.g. cost of goods sold, staff remuneration, professional fee, etc.
- Costs incurred for both classes of income shall be apportioned based on appropriate allocation keys e.g. rent –floor space occupied; staff remuneration -man-hour
- Where appropriate allocation key cannot be determined, allocate using pro-rata basis
- Penalty and Fines
Penalty or fines imposed pursuant to legislation enacted by the National Assembly or a State House of Assembly shall not be allowed for tax purposes. Any expense incurred for the violation of laws and subsidiary legislations or regulations made pursuant to the legislation. eg. Transfer Pricing Regulations will not be deductible.
- Payment of Minimum Tax
The minimum tax is computed at a fixed rate of 0.5% of ‘gross turnover’ to exclude franked investment income. For tax returns that fall due for any year of assessment from 1st January 2020 up to December 2021(both dates inclusive), the minimum tax rate is 0.25%.
Based on the circular, gross turnover, for the purposes of minimum tax has been amended to include all incomes from operating activities, sales of goods, supply of services and all other investment income as reflected in the financial statements, books or records, but which does not include increases relating to contributions from equity participants.
- Gas Utilisation
Section 39 of CITA, as amended, provides incentives for companies engaged in a trade or business of gas utilisation in downstream operations, including an initial three-year tax-free period renewable for another two years, additional investment allowance, etc.
The circular clarifies that the gas utilisation incentive will now apply to a trade or business (of gas utilisation in downstream operations). Hence, if a company engages in more than one business that qualifies for the gas utilisation incentive, the incentive will be limited to only that business.
FIRS clarified that a company engaged in upstream petroleum operations and downstream gas utilisation that has enjoyed similar incentives under the Petroleum Profits Tax Act (PPTA) cannot benefit from the incentives provided under section 39 of CITA. Similarly, a company that has enjoyed the incentives under section 39 of CITA shall not claim similar incentives under any law in Nigeria, e.g., the pioneer tax incentives in the Industrial Development (Income Tax Relief) Act (IDITRA).
- Taxability of Interest Payable on Loan
Section 39(1)(e), which required the Minister’s prior approval for the deduction of interest payable on any loan obtained for a gas project, has been deleted by the FA 2020.
Now, such interest shall only be deducted if it satisfies the WREN test, if incurred to generate taxable income, and satisfies the interest deductibility rules introduced by section 24(a) and the Seventh Schedule of CITA.
- Self-Assessment of Tax Payable
Generally, companies are to file tax returns with evidence of payment of tax due. However, where the company, by a deliberate and dishonest act, fails to declare the true and right amount of tax payable fully, or submits an incorrect statement, the company is liable to pay outstanding tax including penalties and interest from the date in which the tax return was due.
In the circular, FIRS gave examples of a deliberate and dishonest act to include:
- Inflating expenses or other tax deductions
- Suppressing of income
- Deliberately omitting information on the tax returns
FIRS also stated that additional tax arising from a desk review, tax audit, tax investigation or any examination by the Service should attract penalty and interest, accruing from the date the incorrect return was due.
- Computation of Penalty and Interest
Penalty and interest will be imposed from the date an incorrect return was due. As such, it is required of every taxpayer to ensure the right amount of taxes are paid.
- Time Within Which Tax is to be Paid
Section 77(2) of CITA LFN 2004 was amended to reduce the time within which tax is to be paid from 60 days to 30 days after the service of Notice of Assessment. Therefore, companies are to pay tax assessments not objected to or appealed within thirty days of service
- Definition of Public Character
Public Character has now been defined to mean any organisation or institution:
- That is registered under relevant law in Nigeria
- Does not distribute or share its profit in any manner to members or promoters.
The registration must be under the relevant law of the Federal, State or Local Government in Nigeria. Furthermore, the profit of such institutions should not be paid or transferred directly or indirectly by way of dividends or bonuses to its members, trustees or promoters.
Generally, this circular clarified some of the issues raised by the previous circular and expounded on many of the changes from the FA 2020 as follow:
In defining gross turnover for minimum tax purposes, the FIRS did not consider fully the phrase “arising in the course of the operating activities of an entity”. Taxpayers may argue that inflows to be included in gross turnover to calculate minimum tax should be limited to income from the business’ primary activities. Therefore, they may argue that receipt of interest, rents, and royalties should only be subjected to minimum tax if the company actively earns such income.
Exemption for Agricultural Trades or Businesses
One of the qualifying conditions for minimum tax exemption is carrying out “agricultural trade or business” as defined in CITA. The FA 2020 section defines ‘agricultural trade or business’ (section 11(4)) has been replaced with ‘primary agricultural production. Hence, companies that operate in the agricultural industry that previously enjoyed minimum tax exemption need to revalidate whether they still qualify for minimum tax exemption based on the more restrictive definition of “primary agricultural production”.
Similarly, companies in the “agro-allied” industry that enjoyed an exemption from the ⅔ of total profit restriction on the claim of capital allowance will need to re-evaluate whether they still qualify for this exemption based on the (current as of 25th October 2021) definition of primary agricultural production.
Small companies and CIT
The FIRS has modified its position slightly in this circular by deleting its previous statement in the FA 2019 circular that a company that defaults in meeting the conditions will forfeit its tax exemption. The new update brings the circular in line with the law as a small company can be liable to penalties for other defaults while enjoying tax exemption.
Expenses incurred in earning exempt income
The new method introduced by the FIRS for allocating expenses is more detailed than its previous circular. Taxpayers should keep track of expenses incurred solely to generate exempt income and disallow them. Suitable allocation keys should be determined and used to apportion the joint costs. Apportionment using the ratio of tax-exempt income to total income should be a last resort for expenses for which a more suitable allocation key cannot be determined.
Penalty and Fines
The FIRS has now clarified that penalties or fines imposed pursuant to any legislation, as well as violation of subsidiary legislations, will be disallowed. Though CITA does not mention subsidiary legislations, disallowing penalties under the principal Act would mean that any penalty under subsidiary legislation made pursuant to the principal Act should also be disallowed.
Self-Assessment of Tax Payable
The FIRS has now given examples of deliberate and dishonest acts. The concern here is that the FIRS will be the one to determine whether an act was done deliberately or dishonestly, which brings subjectivity to the process. It is hoped that the FIRS will only seek to characterise taxpayers’ actions as deliberate and dishonest when there is clear evidence of such. Otherwise, the position of the FIRS could be challenged at the Tribunal and in the courts
Organisations who are engaged in ecclesiastical, charitable and educational activities who want to claim the tax exemption under CITA must now be registered in Nigeria to be public. However, the word registration used in the law is not necessarily incorporation. The restriction on the distribution of dividends and bonuses will likely exclude limited liability companies from qualifying for the exemption.